There are a number of new agency initiatives hitting the ground on the issue of independent contractor status.  I have blogged on these and now find that the IRS has come out with something that may be very good or very bad for employers.  The IRS, in a program entitled the Voluntary Classification Settlement Program (VCSP) is going to allow taxpayers (i.e. employers) to voluntarily re-classify workers as employees for federal tax purposes.

This is, to put it mildly, an interesting development and it remains to be seen whether this will help or very much hurt the business community, because I fear that, with all the new agency sharing of information initiatives (some I have blogged about), such a voluntary re-classification may have a snowball effect for employers and they will be providing the best evidence of their alleged wrongdoing for the other agencies (e.g. State unemployment bureau).

The VSCP is optional and allows for employers to re-classify employees with limited federal employment tax liability for the prior “transgressions” of not treating these individuals as employees.  To participate, the employer must meet certain conditions, must apply to the program and must enter into a written agreement with the IRS.  The IRS has concluded that it is beneficial to provide employers with this mechanism to covert workers, as opposed to the traditional, administrative and (often) adversarial process that takes a great deal of time and a great deal of money (e.g. legal fees) to ultimately resolve.

In order to “take advantage” of the VCSP, the employer must have treated the workers as independent contractors and must have filed the 1099 forms for these workers for the prior three years.  The employer cannot currently be under an IRS audit (or a state agency) relating to the workers it wishes to change.  Lastly, an employer who has been previously audited by the IRS or the Department of Labor regarding the workers can only enter the program if the employer has complied with the audit’s results.

The employer who enters the program must agree to treat the people as employees in the future. In exchange, the IRS will permit the employer to pay only 10% of the taxes that otherwise would have been due.  The tax will also be computed on a reduced rate basis under IRC Section 3509. There will also not be any imposition of interest or penalties on the assessed taxes.  Lastly, and this may be the most significant aspect, there will not be any audit of these workers for prior years. In sum, it sounds like a pretty decent (no pun intended) “get out of jail free” card.

Sounds good, but the IRS is only one agency.  Once the employer enters the program and re-classifies for IRS purposes, does it have to do that for all purposes.  What if the state unemployment agency audits?  What defense will be left after the IRS, employer-initiated re-classification.  The answer to that is, I believe, none.  So, employers should be wary of entering this seemingly enticing program because such entrance may have far reaching, and unintended, consequences.